The Second of the Twin Dangers

In a previous post, I gave some cautionary advice and questions relative to a borrower signing a personal guaranty. That personal guaranty allows the creditor to pursue any other assets then owned or acquired in the future by the guarantor should the note go into default and a judgment be obtained. These personal guaranties are frequently required in commercial lending environments wherein the main borrower is an entity such as a corporation or an LLC.

The second of the twin dangers is a cognovit promissory note. I realize that not all states recognize and permit cognovit promissory notes. Those states that do only allow them to be used in a business context; however, I have often seen real estate investors who are borrowing money for their business, or for a rehab or flip, willingly sign a cognovit promissory note without fully understanding what can occur.

A properly formatted cognovit promissory note includes the warning language and agreement that the borrower will, in the event of default, allow for the lender to immediately sue and obtain judgment against them. In other words, the lender/creditor can sue on Monday and, with the filing of the lawsuit, file an answer with the court confessing or admitting to judgment requested in the lawsuit. This means that by Tuesday, the lender/creditor can have a court order signed by a judge granting them judgment in the full amount of the unpaid balance with no opportunity for the borrower to challenge, defend or question the allegations that have just been filed by the lender/creditor. It’s an open and shut case; borrower loses!! That cognovit judgment then becomes a very powerful collection tool to be used in conjunction with a personal guaranty to place liens on any other assets owned by the debtor or guarantor.

I have also seen instances wherein bank attachments and garnishes were filed immediately thereafter based upon the filing of the lawsuit and the confession of judgment according to the terms of the cognovit note, which means it is possible for the borrower/guarantor to not even know they have been sued until after their bank account has been frozen or cleaned out. I don’t think I have to describe to you how paralyzing that can be to a borrower who is in default to have all their money taken from them and have no ability then to retain counsel to fight this situation and try to mitigate the damage.

If you think I’m exaggerating, allow me to share with you one instance in which` I watched a lender holding a cognovit note with a personal guaranty craftily lure the borrower into default by promising a refi that he then delayed. At the closing of the refi, the lender insisted on an extra $15,000 in late fees, penalties and accrued interest, leaving the borrower with the choice of paying that extra money at the refi closing or risk having judgment immediately obtained against him for the full amount of the note he thought was going to be refinanced 60 days earlier.

By now I trust you can understand how powerful these tools are in the hands of a lender or debt collector, particularly one who lacks morals and ethics. That’s why many states no longer permit them to be used. In those situations in which they still can be used, you, the borrower, must be informed and prepared when your lender asks for that type of note or instrument to be signed.

In case you’re wondering, when I represent lenders in commercial transactions, I do my best to get strong personal guaranties and cognovit notes signed by the borrowers. After all, I’m doing everything I can to protect and secure my lending client’s position.

I hope this helps you be better informed for the next time you have to make a borrowing decision.

Hedge fund manager and former Goldman Sachs partner Steven Mnuchin confirmed to CNBC on Wednesday morning that President-elect Donald Trump has nominated him for the position of Secretary of the U.S. Department of the Treasury.

Trump’s choice of Mnuchin, 53, who served as the President-elect’s national finance chairman during his campaign, is considered controversial because Mnuchin has never worked in government and his roots in Wall Street would seem to conflict with Trump’s anti-financial industry sentiment during his campaign.

One area where he does agree with Trump, however, is the need for reduced regulation. Mnuchin laid out a number of his initiatives on CNBC’s Squawk Box, should the U.S. Senate confirm him as the 77th Treasury Secretary. One of those is to roll back the Dodd-Frank Wall Street Reform and Consumer Protection Act, which passed in 2010 and is considered by the Obama Administration to be one of its greatest achievements. In various speeches and interviews throughout his campaign and since his election, Trump has vowed to overhaul the controversial financial reform law.

“We (Mnuchin and Trump’s choice for head of the U.S. Department of Commerce, Wilbur Ross, also announced on Wednesday) have been in the business of regional banking, and we understand what it is to make loans,” Mnuchin told CNBC. “That’s the engine of growth to small- and medium-sized businesses. The number one problem with Dodd-Frank is it’s way too complicated and it cuts back lending. So we want to strip back parts of Dodd-Frank that prevent banks from lending, and that’ll be the number one priority on the regulatory side.”

Mnuchin told CNBC that the U.S. economy can sustain a growth level of between 3 and 4 percent. In fact, he called sustained economic growth “our most important priority.”

“It is absolutely critical for the country,” Mnuchin said. “We absolutely can have sustained growth at that level. To get there, our number one priority is tax reform. This will be the largest tax change since Reagan. We’ve talked about this during the campaign. Wilbur and I have worked very closely together on the campaign. We’re going to cut corporate taxes, which will bring huge amounts of jobs back to the United States. We’re going to get to 15 percent, and we’re going to bring a lot of cash back into the U.S.”

In an interview with Fox Business after the announcement of his nomination, Mnuchin said he believes that the controversial government conservatorship of Fannie Mae and Freddie Mac should end and that the private market should have more of a share in the mortgage market.

“We will make sure that when they are restructured, they are absolutely safe and don’t get taken over again. But we’ve got to get them out of government control,” Mnuchin said, according to Bloomberg.

“A resolution of the conservatorship of Fannie and Freddie appears likely with Mnuchin as Treasury secretary,” says Tim Rood, Chairman of The Collingwood Group. “His experiences at Dune Capital, particularly the IndyMac/OneWest purchase and turn around, will most certainly influence his decision-making calculus.”

Five Star Institute President and CEO Ed Delgado said of the nomination of Mnuchin for Treasury Secretary: “I anticipate that with this new appointment, Treasury will continue to promote the department’s mission by encouraging a strong economy and creating economic growth and stability. As the economy further recovers from the Great Recession it is imperative that the housing industry and Treasury work in hand and hand to ensure housing and economic prosperity.”

Mnuchin left Goldman Sachs in 2002 after 17 years with the global investment banking firm to become vice chairman of hedge fund ESL, and he later became CEO of another hedge fund, SFM Capital Management. In 2009, Mnuchin and a group of investors purchased the failed Pasadena-based IndyMac bank from the FDIC for $1.5 billion after the mortgage meltdown and renamed the bank OneWest. In the years immediately following the crisis, OneWest’s foreclosure practices generated considerable controversy, particularly in California.

“If he gets the post, Mnuchin will bring a lot of mortgage expertise to the Treasury Department,” says Rick Roque, President of Menlo. “He bought Indymac, renamed it OneWest and then sold that company to CIT Group in 2015. That kind of experience, in addition to his experience in sub-prime origination, retail origination, and correspondent channels will prove to be very valuable to the non-depository mortgage banking market.”

This important legal document should be kept in a safe place, and here is why!

The promissory note is a promise to pay or IOU from the property buyer. It spells out the amount due and terms of repayment. In legal jargon it is known as a negotiable instrument. Similar to a check, the original must be presented to collect or prove ownership.

If the seller desires to sell and assign the payments to a note buyer, the investor will ask for the original note to be provided at closing. The promissory note is then endorsed over to the investor. Similar to endorsing a check, the holder signs on the back of the note.

Sample Note Endorsement on Back of Original Mortgage Note

Pay to the order of, (Insert name of investor), without recourse.

Dated this ____ day of _______, 2011.

(Seller Signs and Dates)

Sometimes the note endorsement is executed on a separate piece of paper, also called an allonge. The allonge is then attached as a permanent rider to the original note. The endorsement enables the investor to prove they are a holder in due course, with the same rights of repayment as the original note holder.

An investor may also ask for the original recorded mortgage or deed of trust at closing. However, if this original is lost, an investor will usually accept a certified copy from the county recorder’s office.

A lost original note, on the other hand, can cause a problem. In most states the note is not recorded. If the original note becomes lost a note investor may ask for a duplicate or replacement note to be signed by the payer or maker. This means going back to the person that owes you money and asking them to resign. This relies on their cooperation and can cause delays.

The investor will also ask for a lost note affidavit from the seller or note holder, stating the note has been lost and it will be presented if found at a later date.

Some investors will consider accepting just the lost note affidavit with a copy of the original note. However, this is increasingly rare as a lost original note can create problems foreclosing should the buyer stop making payments.

The best option is to avoid losing the note by keeping it in a safe deposit box or a fire and waterproof safe. Some sellers elect to have the original held by their attorney or a third party servicing agent for safekeeping.

Whatever method you choose, be sure to keep the original mortgage note in a safe place that is easily located!